Schwab selling stock to support growth in its bank

Charles Schwab said today it is selling 26.3 million shares of common stock, in part to support the potential migration of certain client assets from Schwab’s money market funds to its bank accounts.

The accounts targeted for possible conversion are sweep accounts. When a brokerage customer sells an investment or receives dividends or interest, the idle cash is swept into a sweep account, where it sits until the client does something with it.

Normally when firms change sweep accounts, “they do it through negative consent,” says Michael Hecht, an analyst with JMP Securities. They send a letter to the customer saying that if you don’t respond within a certain number of days, we will move your account.

Schwab stock closed today at $19.29, up 29 cents. At that price, the stock sale would raise about $500 million. Underwriters have an option to purchase an additional 3.9 million shares. The stock sale would add roughly 2.5 percent to Schwab’s shares outstanding.

The company said it “intends to use the net proceeds of the offering to support balance sheet growth, including expansion of the company’s deposit base and potential migration of certain client balances from money market funds into Schwab Bank, which may be subject to notice and/or approvals from regulators and clients.”

Back in November, Schwab said it might move up to $10 billion in client assets from money market funds to its bank in 2010. To support $10 billion in deposit growth, the bank would need about $600 million in additional tier one capital, Hecht says.

The company also needs capital to support “organic growth” from customers moving into bank accounts on their own, he adds. At the end of 2009, Schwab had $38.8 billion in deposits from banking clients, up from $23.8 billion at the end of 2008.

Over that same period, assets in Schwab’s proprietary money market funds fell to $171.2 billion from $209.7 billion.

Schwab is not in dire need of capital to fund deposit growth, Hecht says. At the end of December the parent company had $1 billion in cash and liquid investments.

Over the years, many brokerage firms have changed their sweep accounts from money market funds to bank accounts because they generally make more money on bank products.

That’s especially true now. With short-term interest rates so low, many money fund managers, including Schwab, are waiving part of their fees to prevent yields from going below zero. Schwab’s main money market fund is yielding 0.01 after fee waivers.

Normally Schwab’s fees are close to 0.6 percent of assets invested in its money funds. Today they’re around 0.4 percent, Hecht says.

Schwab can earn more than 0.4 percent on banking deposits because it can loan them out at higher rates or invest them in higher-yielding securities. Schwab pays an average of 0.36 percent on its bank deposits and earns about 2 percent, Hecht says.

Today, Schwab sweeps cash into money funds or bank accounts, depending on the size of the client’s household assets at Schwab. Both are yielding 0.01 percent (although a money fund for larger accounts is yielding 0.07 percent). The bank account is FDIC-insured, the money market funds are not.